Surely we have been here before? British Airways is talking about merging with KLM just as it did a decade ago; the US majors, led by United Airlines and US Airways, are again in the throes of consolidation and analysts on both sides of the Atlantic are back calculating how many truly global players can eventually emerge. But will this round of merger attempts be any more successful this time?
There are a few reasons to believe that they just might. For a start, the world is a less regulated place than it was a decade ago. Back then, Europe's liberalisation was still in its infancy and the USA had yet to start prizing open the transatlantic with its open skies initiative. Today, globalisation has begun to look more like a fact of corporate life for everyone - politicians included. Witness the unexpected pace of cross-broader merger activity in other sectors from telecommunications to automotive. Just like air transport, those too were once regarded as untouchable national assets in Europe and as prime targets for trust busting in the USA.
Airline alliances have already set that globalisation in motion. This year's Alliance Survey, conducted by Airline Business, shows the frenzy of deal-making that has taken place in the second half of the 1990s. There are a staggering 579 bilateral partnerships in force among more than 220 mainline airlines, and most of those were signed in a sudden spurt during the last three years. At least three quarters of the deals are in the form of codeshare agreements (see graph over page).
The emergence of the global alliance has begun to add another strand to the debate (see page 50). The Star Alliance accounts for around 20% of the world passenger market whichever way you cut it and could edge closer to 25% as existing members bring in new partners to the fold such as US Airways and Canadian International. Closest competition still comes from oneworld, although reduced to a share of around 16% following the Canadian departure. Other alliances are trailing in the distance, at least on this rough measure of world market share.
The European realignments that have now been made possible since Alitalia and KLM parted company in April, together with some interesting new permutations across the Atlantic, suggest that there is still room for another couple of groupings able to catch Star, although simple mathematics seems to rule out more than that.
Competition hurdles
Clearly, the proposed BA/KLM and United/US Airways mergers could still founder, not least on the issue of competition. But there are signs of a little more caution among regulators and competitors alike in ruling the deals out of court as they may have been tempted to do in the past.
In Europe, Brussels has quietly acknowledged for some time that consolidation among its majors may be inevitable and perhaps even desirable if they are to retain a leading role on the world stage. It is now stated policy that national flag carriers which run into trouble in future will have to look for mergers rather than state aid.
Europe's first true cross-border deal has already been quietly allowed through, in the shape of the SAirGroup's effective acquisition of Sabena, now merged under a single management umbrella with Swissair. The proposed KLM/Alitalia merger also cleared competition scrutiny, before falling apart for commercial reasons.
The BA/KLM merger is clearly on a grander scale than either of those deals, potentially creating a $20 billion giant to top the industry league tables. That is not necessarily a reason for it to fail.
BA's long-standing domestic adversaries, easyJet and Virgin, have predictably taken the opportunity to complain about a link with KLM. But other majors have been less keen than usual to throw in rocks from the side as they weigh up their own next move.
If BA/KLM does fail, most analysts believe it will again be on the ticklish issue of valuation. That was what killed the deal a decade ago as KLM demanded too large a slice of the resulting merged company. Yet both carriers are both publicly committed to finding some kind of merger, with each other or not.
Others in Europe, too, are considering their positions. Lufthansa more or less founded Star on the principle that operational co-operation, rather than equity stakes, is the key. But it is well placed to turn partnership into merger if and when the opportunity emerges with near neighbours SAS and possibly Austrian Airlines. In private, at least, neither of those two partners are exactly ruling out the possibility if the landscape starts to change.
Many of the same themes are being played out on the US side of the Atlantic. US competition hurdles may be higher for United and US Airways, or other network majors hoping to find their own partner. The same dance two years ago ended inconclusively, with Northwest taking a stake in Continental but finding itself in limbo thanks to antitrust rulings.
This time there is already one notable difference - the usual barracking from rival carriers is missing. So silent have they been that in the recent round of hearings into the deal, Congress has struggled to find any to come and put the opposing view. James Oberstar, a long-standing face on the House Transportation Committee, complains that only one side is talking to Congress.
"Many major airlines will tell you in private that they wish this proposal would go away. But they are afraid of publicly saying anything that might be used against the mergers they will want to pursue if the United-US Airways deal is approved," he says.
It is possible that the other mergers talks taking place in the shadows are once again a spoiling tactic, designed to frighten Congress with the possibility that if they allow through United's proposals the flood gates will be opened. Or, perhaps there is genuine concern that the deal will go through and that they will indeed have to respond to survive.
Whatever the motivation, silence is a prudent tactic given the cleverness of the United-US Airways proposal, which has enjoyed the advantage of being put together behind closed doors and bears all the hallmarks of political savvy on the part of Stephen Wolf, currently chairman of US Airways and formerly of United.
For a start, the timing is good. US majors have been lobbying hard against the threat of market "re-regulation", arguing that government should stay out of aviation. It would appear hypocritical for those same airlines now to call for government intervention to prevent this merger.
The merger proposal also includes a sweetener - the possibility of the first-ever start-up carrier being created at Washington's National airport (now dubbed Ronald Reagan). Unlike more distant hubs at Dulles or Baltimore, the centrally-located National has commanded higher fares and is popular with Congressmen. US Airways, which dominates the airport, has promised to make room for new low-fares competition, which on paper at least, is a difficult proposition to fault.
Congressional reaction
As in Europe, there are nevertheless hurdles ahead. The reaction from Congress has been swift and predictably sceptical. During the first of a string of hearings, one Congressman bluntly pointed out that the real winners would be the two airlines, their stockholders and "probably half the lobbyists in Washington". Congress has no vote on the deal, but holds considerable political sway over the review processes that the Departments of Justice and Transportation (DoJ/DoT) will conduct.
It will be difficult for either department to sound too favourable given their recent warnings about lack of airline competition, especially from the DoJ. "The DoJ would have to change its apparent point of view of the industry; their vision is one of the industry being on the verge of dangerous consolidation. It's unlikely the deal will go through unless the government makes a major change in its competitive policy." says Michael Levine, a Harvard law school professor and former board member at Northwest, whose deal with Continental the DoJ helped to stall.
Union issues also must be resolved. While employees at both airlines have been given a no-furlough protection promise, there are integration and seniority ramifications that concern United pilots and which could prove a deal killer.
Finally, United stockholders may also need some convincing. "They're not raising prices and there will be no lay-offs for a couple of years. Under those circumstances, investors will ask where's the pay-off?," says Daniel Kasper, managing director of LECD Consultants.
Analysts in Europe raise similar doubts over BA's chances of justifying the current KLM asking price. In principle their operations seem complementary, with KLM focused on the lower-yield transfer market which makes up an important third of its traffic through Amsterdam, while BA cultivates direct business travellers out of London Heathrow. As recent results have shown, however, KLM's cost base is little better than BA's. To make the deal work, some reckon that the merged group would have to look for cost cuts of up to 20% - a bitter pill for unions or politicians to swallow.
While both mergers may have some claims to interesting network synergies, cost savings and economy of scale are the real drivers here. That is in contrast to the intercontinental alliances where access to otherwise unreachable markets has been the prime objective. The Future of Airline Alliances, a study published jointly by Gemini Consulting and Airline Business at the start of the year, suggests that outright merger, or something close to it, should free the partners to achieve cost savings in double digits across their businesses. Looser co-operation among independent alliance partners would be lucky to achieve half of that result.
Neither of the mergers, as they stand, is being given much more than a half chance, but, equally, few are prepared to write off their chances altogether. To start, there are external factors which could still swing opinion more clearly in favour of allowing through this latest consolidation.
Gathering momentum
The outcome of this year's US presidential election might change the odds for the United/US Airways proposals. A Republican Administration led by George W Bush might be less concerned about industry consolidation than its predecessor. Also, if merger fever creates new European giants, Congress may take a different perspective. The new European Commission that came in last year has shown signs of being receptive to similar arguments about the competitive standing of its own carriers in the world. In short, the deals could gather momentum from each other. They would clearly set a new benchmark for carriers at the top of the world rankings, both creating groupings which are a head taller than their nearest rivals.
At present, United sits atop the US league with a domestic market share of 20%. American and Delta are in close touch, followed at a distance by the others. The big three of BA, Lufthansa and Air France are in only a slightly less dominant position within Europe. A combined United/US Airways would stand to take its share above 25% in the US domestic market, while BA/KLM goes to 20% in Europe.
It is not only their smaller rivals who could have cause to fear such scale. Respective global alliance partners in Star and oneworld may suddenly find themselves in a less than equal marriage.
American is already rumoured to have opened discussions with Delta and Northwest. Notably its oneworld partner BA has also effectively been in talks with the same names. The UK carrier had opened a dialogue with Air France, and KLM brings Northwest with it.
Chances of American and Delta being allowed to do serious business are extremely remote, given that they would together command over a third of the US market. Some question whether such a proposal would be anything more than a spoiler. Last time around, it was a proposed co-operation between United and Delta that helped scare regulators away from allowing Northwest/Continental and American/US Airways.
American's chances with Northwest look more plausible, creating an airline group only slightly larger than a post-merger United. Northwest would strengthen American's weak spots on the transpacific and mid-West. More than that, it could also provide the perfect complement to BA/KLM in Europe. Similarly, Lufthansa could look to SAS to strengthen its position next to an enlarged United.
The permutations are endless, and still to be played out. In the USA, Continental and Northwest could revive their plans or seek other partners. Delta would presumably be one keen buyer. The final unknowns in this latest whirl of merger talks is what the fall-out might be for the smaller carriers.
Alaska Airlines and America West are prime candidates for takeovers and could provide useful regional extensions to one of the global alliances. TWA, although in need of substantial restoration, could find a buyer ready to takethe risk.
It remains far from certain that either of the current big deals, or others, will go through. But if nothing else, it seems that after a decade of alliance-making, the airline industry is in the mood to consolidate. And it may only take one major move to trigger a full blown frenzy.
| The Global alliance groupings - Current standings June 2000 | ||||||||
| Passenger traffic | Passenger numbers | Group revenues | Destinations | Fleet | ||||
| RPK bn | Share* | $million | Share * | $ billion | Share* | |||
| Star Alliance | 594 | 21.3% | 293 | 18.8% | 69.6 | 20.9% | 800+ | 2023 |
| Oneworld | 456 | 16.4% | 199 | 12.8% | 50.0 | 15.0% | 559 | 1852 |
| Air France/Delta | 265 | 9.5% | 151 | 9.7% | 26.1 | 7.8% | 454 | 883 |
| Northwest/KLM | 177 | 6.4% | 72 | 4.6% | 16.8 | 5.0% | - | 487 |
| Qualiflyer | 100 | 3.6% | 52 | 3.3% | 16.1 | 4.8% | 332 | 469 |
| Total alliances | 1592 | 57.1% | 766 | 49.1% | 178.6 | 53.7% | - | 5714 |
| NOTE: * Share=estimated share of world mainline scheduled traffic/airline group revenues Includes all partners which have committed to the alliance, including those who have signed but where membership is still pending. Associated bilateral members have not been included. | ||||||||
Source: Airline Business
